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					                                                                  Chapter 3
Finance

                                                   In this chapter we look at the
                                                   importance of finance to a busi-
                                                   ness and examine the sources of
                                                   finance available when setting
                                                   up a small business.



Finance and support for a small
business
     Before a new business can start trading, it needs to raise money to buy raw materials, pay
   rent or buy buildings and all the other things it will need. This section explains how a busi-
   ness might raise money, why this might be difficult and who might help an entrepreneur to
   start a new business.
     By the end of this section you should know:
     ✓	the sources of finance for a new business
     ✓	the sources of advice and help for a new business

Sources of finance for a new business
  An entrepreneur who is looking for money to start a new business is said to be
  ‘raising finance’. The places in which he or she might find the necessary money are
   called sources of finance (see Figure 3.1 on page 52). These are summarised below.
   Most new businesses will use one or more of these sources of finance to raise the
   money needed to start trading.




AQA GCSE Business Studies                                                                           1
Unit 1 Setting up a business

                                                 Government grants
                                Hire purchase
                                  and leasing                         Selling shares


                                                 Sources of finance
                    Loans from friends               for a new               Owners’ funds
                            and family               business


                                   Overdrafts                         Bank loans
                                                     Mortgages
           Figure 3.1 Summary of the sources of finance for a new business


       Why do new businesses need to raise finance?
          A new business will need finance (money) to purchase a range of items that are
          essential if it is to be able to start trading. An entrepreneur will need to spend
          money on at least some of the following in order to start a business:
          ✱	 Renting or buying a building. This might be a shop, an office or a factory and is

             likely to be relatively expensive.
          ✱	 Vehicles. Many businesses will require cars to visit customers and suppliers, or

             vans or lorries to deliver products.
          ✱	 Advertising the business. Potential customers will not know about a new busi-

             ness unless it promotes itself. Many new businesses spend quite large amounts of
             money on advertising, even before they start trading.
          ✱	 Equipment and machinery for the business. Most businesses require some equip-

             ment or machinery, especially if they are planning to manufacture products. For
             example, a new furniture-making business will need equipment to cut, sand and
             polish wood.
          ✱	 Stock of raw materials. A shop

             will need stock to sell. So, for
             example, a greengrocer will need
             to buy stocks of fruit and vegeta-
             bles to sell. The furniture-maker
             referred to above will need to have
             wood, nails, screws and wood
             stains to construct the furniture.

     If you were starting a business similar to the one
     in the photograph, what would you need to buy
     before you could start trading?





                                                                                               Finance    3
Owners’ funds
   Owners’ funds is the name given to money put into the business by its owners.
   There might be one or more owners of a new business, depending on whether the
   business is set up as a sole trader, a partnership or a private limited company. The
   greater the number of owners in a business, the more important owners’ funds
   become as a source of finance. The owners of a new business may use their savings
   to invest in their business — if they have any. It is common for entrepreneurs to use
   redundancy payments as a source of finance. People receive redundancy payments
   as compensation when they lose their job.
     Owners’ funds are normally used as a source of finance when the business is first
   set up, but they can also provide money for well-established businesses. Owners’
   funds are a major source of finance for sole traders and partnerships, which are not
   allowed to sell shares to raise money. A major benefit of using this source of finance
   is that the business does not have to pay any interest on it.

Bank loans
   If a bank believes that an entrepreneur has a good business idea and will be able to
   repay any money it lends, it may agree to create a loan to help start the business. A
   bank loan involves a bank giving a business a large sum of money in return for the
   business agreeing to repay the amount in instalments over the next few years. The
   business will also be charged interest on the loan. This is an extra payment that
   the borrower has to make to the bank and allows the bank to make a profit on its
   lending activities. If the interest rate that is charged is high it may make bank loans
   an expensive source of finance. New businesses are often considered to be risky as
   they have few, if any, customers and may not be able to sell enough products to
   repay any loan. Banks normally charge new businesses high rates of interest if they
   agree to give a loan.
                                             Banks may also ask a business for collateral
                                          before they agree to a loan. Collateral is some-
                                          thing that can be sold if the business does not
                                          repay the loan. An example of collateral might
                                          be that the bank is given the right to sell the
                                          entrepreneur’s house if it does not receive
                                          repayment of the loan. In this way, the house is
                                          collateral for the loan.

                                      One of the Cooperative bank’s branches. Banks often
                                         think that new businesses are risky (that is, likely to
                                    fail) and may be unwilling to lend them money. Why do
                                            banks consider many new businesses to be risky?



AQA GCSE Business Studies                                                                            
Unit 1 Setting up a business

       Mortgages
         Mortgages are loans from banks and building societies that are used to buy land
         and buildings such as offices and shops. The business is given the sum of money
         by a bank or building society and has to make regular payments until the money
         and any interest has been repaid.
           Mortgages are normally very long-term loans of up to 30 years. The amount of
         money borrowed is often large because land and buildings are usually very costly.
         The building or land purchased with the mortgage is normally used as collateral (or
         security) for the loan. If the business fails to make repayments on the mortgage, the
         bank or building society will sell the building or land to regain its money.

       Overdrafts
         Overdrafts give entrepreneurs and businesses the right to borrow variable amounts
         of money up to an agreed limit. Overdrafts are very flexible loans as businesses
         only use them when required (see Figure 3.2).

                                    2500
         Bank account balance (£)




                                            Balance when
                                    2000    business starts                        Customers pay
                                               trading                              for supplies
                                    1500
                  Positive




                                                               Balance falls and                 Business spends
                                    1000                      becomes negative                 heavily on advertising
                                     500                       in early months                    and supplying
                                                                  of trading                          products
                                       0
                                             1   2    3   4      5   6    7   8      9   10   11   12 13   14    15 16 17
                                     –500
                                    –1000
                    Negative




                                    –1500
                                    –2000
                                                                                                                     Agreed
                                    –2500                                                                           overdraft
                                    –3000                                                                             limit
                                                                           Times when the business              Time (months)
                                                                             is using its overdraft

         Figure 3.2 How a business might use its overdraft

           In the graph above, a new business has agreed an overdraft of £2,000 with its
         bank. This means that the business can borrow any amount up to £2,000 from the
         bank for any period it chooses. An overdraft is a flexible loan in that a business
         uses it only when it needs to do so, in this case between months 4 and 8 and 11 and
         16. At other times the business does not need to borrow any money. In this way, the
         business only pays interest for the few months that it needs to do so.
           Overdrafts do have disadvantages for new businesses, however. First, a bank may
         not agree to grant a new business an overdraft. If it does so, the rate of interest will


                                                                                              Finance    3
   be relatively high, making this an expensive source of finance. Finally, a bank may
   withdraw a business’s overdraft with little notice, leaving it with serious financial
   problems.

    Key terms
    Owners’ funds is money put into a business by its owner or owners.
    Interest is a payment made in order to borrow money. It means a business pays back more
    than it borrows.
    Overdrafts give entrepreneurs and businesses the right to borrow variable amounts of
    money up to an agreed limit.
    Mortgages are loans from banks and building societies that are used to buy land and
    buildings such as offices and shops.


Loans from friends and family
   Borrowing money from friends and family is a popular source of finance for many
   entrepreneurs who are setting up a small business. This source of finance has the
   advantage of being easy to arrange and often the money will be lent free of inter-
                                              est payments. There are disadvantages,
                                              however. Friends and family may not
                                              be able to lend enough money or may
                                              need to have it returned suddenly,
                                              leaving the business short of finance.
                                              Finally, and importantly, friends and
                                             family will be less likely to look close-
                                              ly at the entrepreneur’s business plan
                                              and to make the entrepreneur think
                                              carefully about the proposed business.

                                               Why might an entrepreneur be worried about
                                              borrowing a large sum of money from a family
                                                           member to start a new business?

Hire purchase and leasing
   An entrepreneur will not be able to raise large sums of money from these sources:
   ✱	 Hire purchase. This is a method of purchasing assets and paying in instalments.

      It is really a special form of a loan. Hire purchase can be an expensive way of
      buying something and the business will not own the item until it is completely
      paid for.
   ✱	 Leasing. This allows businesses to rent assets such as vehicles and photocopiers.

      The business never owns the asset, but does not have to find a large sum of money
      to buy it. Another advantage is that the item will be maintained by the business
      that owns it. Even large, established businesses will lease equipment such as com-
      puters and photocopiers.

AQA GCSE Business Studies                                                                           
Unit 1 Setting up a business

       Government grants
         The government encourages people to start businesses because this creates jobs. In
         addition, businesses pay taxes and this helps the government to pay for its own
         spending plans. A grant is a sum of money given to an entrepreneur or a busi-
         ness for a specific reason. Grants from the UK government are usually given if a
         business will create jobs, especially in areas where many people do not have jobs.
         Government grants will only cover part of the money needed — the entrepreneur
         usually has to put in a sum of money equal to the government grant. The Grant for
         Business Investment (GBI) is suitable for entrepreneurs setting up a business. GBI is
         given to help businesses to buy buildings, machinery and vehicles.
           Grants can be difficult to obtain. Businesses may have to meet a number of condi-
         tions, such as creating a certain number of jobs, in order to qualify. The application
         for grants can also involve completing a lot of forms and an interview. However, most
         grants do not have to be repaid and also do not lead to any interest payments.
           It is not only the UK government that gives grants to businesses. The European
         Union, local governments and charities also offer a wide range of grants.


       Using data
         Ben is planning to start a hairdressing business. He needs to raise £50,000 and
         plans to raise his finance in the following ways:
                                     Owners’ funds          £1,000
                                     Loan from his father   £1,000
                                     Bank loan              £?

          1 How much will Ben need to borrow from the bank?
          2 What percentage of his finance is Ben’s father putting into the new business?

       Issuing shares
         Only companies can sell shares and a new business may be set up as a private lim-
         ited company. We looked at private limited companies in more detail in Chapter 1
         (see pages 26–27). Companies sell shares to shareholders in order to start and to
         expand their businesses. Shareholders are the owners of the business.
           Selling shares can be a relatively easy and cheap source of finance. Companies do
         not have to pay interest to shareholders, although they may pay them a share of the
         profits, known as dividends, if the profits are large enough. However, if a company
         sells too many shares the entrepreneur may lose control of the business.

       Selecting the source of finance
         Many entrepreneurs will use more than one source of finance when starting a new
         business. This is very likely if the entrepreneur needs to raise a large sum of money


                                                                                                    Finance    3
   before trading can start. So, for example, an entrepreneur
   might use some of his or her savings (owners’ funds), borrow                 Examiner’s tip
   some money from friends or family and also have a bank                       Think about which
   loan (see Table 3.1).                                                        source or sources
                                                                                of finance are best
                                 Table 3.1 Types of businesses and
                                                                                for different types of
                                         sources of finance
                                                                                new business. The
    Type of business                                                            summary table on this
                         Possible sources of finance         Key issues
    organisation                                                                page should help you
                                                             l   Banks may      to do this.
                                                                 be unwilling
                        Owner’s funds, government grants
     Sole trader                                                 to lend to a small business.
                        and loans                            l   Sole traders have few internal
                                                                 sources of finance.
                        Partners’ savings, banks,            l   Partnerships often do not have
     Partnership        government grants, hire purchase         enough collateral.
                        and leasing companies                l   Partners may disagree.
                        Suppliers, banks, leasing and hire   l   Larger private limited companies
     Private limited    purchase companies, government           may find it easier to borrow.
     company (Ltd)      grants and loans, venture capital,   l   Loss of control by existing
                        private share issues                     shareholders.



Sources and types of advice for small
businesses
Business Link
   We saw earlier that governments are very keen to encourage new businesses. For
   this reason, they provide help to entrepreneurs in a number of ways. Business Link is
   a major way in which the UK government gives advice to new businesses. Business


    Business insight
    The text below is taken from Business Link’s website. This shows you the range of activities
    carried out by Business Link:
    ‘Businesslink.gov.uk helps your business save time and money by giving you instant access
    to clear, simple, and trustworthy information. It is developed in partnership with subject
    experts within government and relevant business-support organisations to help you comply
    with regulations and improve your performance. Whether you’re starting up, already
    running a business, or looking to grow and develop, we can help you
    l manage your finances                             l employ people

    l find and keep customers                          l pay the correct tax

    l comply with environmental legislation            l trade internationally

    l understand regulations in your sector            l find events and support near you’

    (Source: www.businesslink.gov.uk)


AQA GCSE Business Studies                                                                                 
Unit 1 Setting up a business

         Link is an organisation run by the government that operates in all parts of the UK. It
         helps new and existing businesses to grow and become more efficient and competi-
         tive. Business Link has 45 branches that give businesses advice and support.

       Private websites
         There are many privately owned websites that give advice to small businesses. Some
         may charge for their advice; others are paid for via adverts. Smallbusiness.co.uk is
         perhaps one of the best known of these websites. It is sponsored by one of the UK’s
         largest banks, Lloyds TSB, and offers advice on starting up a business, finance,
         marketing, employing people and the law for small businesses.

       Banks
         The UK’s well-known banks all offer advice and guidance, as well as banking
         services, to new businesses. The advice and guidance given by banks include the
         following:
         ✱	 help with writing business plans

         ✱	 advice on starting a business in particular industries such as agriculture

         ✱	 how to find suitable buildings for the business

         ✱	 the issues involved in employing people

         ✱	 how to trade online


         Banks may give some help to entrepreneurs without charges if the business opens
         an account with the bank.

          Business insight
          Almost £2 million of finance from the European Union has been given to the Institute
          of Digital Innovation (IDI) to help start 90 new companies in the northeast of England.
          Further finance has been given by the UK government and the University of Teesside in
          Middlesbrough. The IDI project aims to help:
          l entrepreneurs to start high-technology businesses

          l university graduates make a business out of their ideas

            The IDI not only provides finance but also offers expert advice to those planning to start
          up a new business.
          (Source: www.smallbusiness.co.uk)
            Why might university graduates find it difficult to raise finance to start a new business?


       Accountants and solicitors
         Entrepreneurs setting up a business can receive               Examiner’s tip
         help from professional people such as accountants             Think about the advantages and
         and solicitors. Accountants will be able to give              disadvantages of each of the
         support in financial matters such as borrowing                sources of finance that a start-up
                                                                       business might use. This will help
         money and paying taxes. Solicitors can offer help
                                                                       you to choose the best one (or
         with legal matters such as setting up a private               ones) for a particular situation.



                                                                                           Finance    3
   limited company or signing a franchise agreement. Professionals such as these will
   be able to offer expert help, but will expect to be paid for their services. Their fees
   can be expensive at a time when a business has little spare money.


Summary
   A new business can raise finance from a number of different sources including
   owners’ funds, overdrafts, bank loans, mortgages, borrowing from friends and fam-
   ily, leasing and hire purchase and selling shares. Each of these sources has advan-
   tages and disadvantages. An entrepreneur can gain help and advice from Business
   Link, many different private websites, banks, accountants and solicitors.

   Quick questions
   1 What is a source of finance?                                              (2 marks)
   2 Explain, with the aid of examples, what is meant by the term
    ‘owners’ funds’.                                                           (5 marks)
   3 What is the difference between a bank loan and an overdraft?              (4 marks)
   4 State one advantage and one disadvantage of using an overdraft
     as a source of finance.                                                   (2 marks)
   5 Describe a mortgage.                                                      (3 marks)
   6 State two reasons why an entrepreneur might decide to borrow
     money from friends and family.                                            (2 marks)
   7 Can an entrepreneur start a business by only using a government
     grant as a source of finance? Explain your answer.                        (4 marks)
   8 Name the government organisation, sponsored by Lloyds TSB,
     that offers advice and guidance to entrepreneurs.                          (1 mark)
   9 State three ways in which a bank might support an entrepreneur
     starting a new business.                                                  (3 marks)
  10 Describe the advice and support that an entrepreneur might
     receive from:
      (i) an accountant
     (ii) a solicitor                                                          (4 marks)




                            Section assessment
                                        Haven
   Peter Miller is only 1, but has set up his own recording studio called Haven in a
   small village in Cumbria. Peter turned down several job offers after university to
   start his business. He is a very skilled musician, but needed help to start his busi-
   ness. In particular, Peter had to raise £,000. The finance was needed to pay for a



AQA GCSE Business Studies                                                                        
Unit 1 Setting up a business

         year’s rent on a suitable building, to buy equipment and to pay for advertising. Peter
         asked his family to lend him £1,00 and also managed to gain a small government
         grant (£,00). He decided to take out a bank loan for the rest, preferring not to
         have an overdraft. He found it very difficult to persuade a bank to lend him money
         as he had not drawn up a business plan.

         Questions
         1 Define the term ‘overdraft’.                                                (2 marks)
         2 Describe two organisations that might have helped Peter to
           start his business.                                                         (4 marks)
         3 Explain why Peter might have chosen to take out a bank loan.                (6 marks)
         4 Would drawing up a business plan have made it easier for
           Peter to raise finance? Give reasons for your answer.                       (8 marks)


         Extension exercise
         Do you think that Peter raised his finance in the right ways?
         Give reasons for your answer.                                                 (9 marks)




       Financial terms and simple
       calculations
           Entrepreneurs need to have a basic understanding of business finance or their businesses
         are very unlikely to be successful. This section introduces you to some important terms and
         shows you, with a number of examples, how entrepreneurs can calculate their business’s
         costs and revenues and determine whether it has made a profit or a loss.
           By the end of this section you should know:
           ✓	the key financial terms used in a new business
           ✓	how to calculate a business’s profit or loss

       Key financial terms
       Price
         Price is the amount a business asks a customer to pay for a single product. When
         you go into a shop, most items for sale have a price attached so you know how much
         you have to pay. An important decision for an entrepreneur is to decide what price
         to charge for his or her products. The entrepreneur will be guided by two things:
         ✱	 the prices set by other similar businesses

         ✱	 how much it costs to produce the good or service that the business sells




0
                                                                                                  Finance    3
                                          Businesses often change their prices. If a
                                        product is very popular an entrepreneur might
                                        decide to sell at a higher price. On other occa-
                                        sions the business might sell the same product at
                                        a lower price. This often happens in shops in late
                                        December and January so that retailers can sell
                                        any goods that are left over from Christmas.

                                    Why might the owner of a fruit stall decide
                                   to reduce prices towards the end of the day?


                                Examiner’s tip
                                Remember that if a business increases its prices it is
                                likely to sell a smaller quantity of its products. Similarly, a
                                price cut might lead to more sales. These arguments can
                                be useful when answering examination questions.

Sales
   This is the number of products sold by a business over some time period, normally
   a week, month or year. For example, a car showroom might sell 95 cars in a year or
   a dentist might treat 125 patients in a week. In each case, the number given is the
   sales achieved by the business. It is important to remember that sales are not stated
   in terms of money. ‘Revenue’ explains how sales are given a monetary value.

Revenue
   Revenue is the income that a firm receives from selling its goods or services. A
   baker’s revenue comes from selling bread and cakes to customers; a cinema’s rev-
   enue comes from selling tickets to people wanting to see films. Revenue may also
   be called ‘income’ or ‘turnover’. A business’s revenue will depend on the price at
   which it sells its products. A business calculates its revenue by multiplying the sell-
   ing price of its products by its sales (or the number of products it sells):
                  revenue = selling price × sales (number of products sold)
   For example, a dressmaker might sell dresses at a standard price of £110. If the
   business’s sales are 12 dresses in a month, the monthly revenue will be 12 × £110 =
   £1,320. We will look at calculating a business’s revenue in more detail later in this
   section.

Costs
   Costs are the spending that is necessary to set up and run a business. A business
   normally has to pay two main types of costs: fixed costs and variable costs.


AQA GCSE Business Studies                                                                               1
Unit 1 Setting up a business

                 Fixed costs
                 Fixed costs do not alter when a business changes its output. A shopkeeper has to pay
                 the same amount of rent or business rates whether the business is attracting large
                 or small numbers of customers. Other examples of fixed costs include insurance for
                 the business’s buildings and fees paid to the business’s accountant. Fixed costs can
                 be a burden for a small business as they have to be paid even if the business is not
                 producing and selling large amounts of its products.
                 Variable costs
                 Variable costs vary directly with the business’s level of output and sales. If a shop-
                 keeper is serving lots of customers then the business will have to buy more stock to
                 sell than if it was not very busy. The shopkeeper might also have to hire more staff
                 to serve in the shop. So, costs such as raw materials and wages vary with output
                 and sales and are called variable costs.
                   Figure 3.3 shows the difference between fixed costs and variable costs. Adding
                 together fixed and variable costs gives the total costs that a business has to pay over
                 a certain time period, such as a month or a year:
                                        total costs = fixed costs + variable costs
                                                                   The costs paid by a business can
     Costs (£)




                         Variable costs rise and fall              be divided up in another way — a
                         according to how much
                         the business produces                     division that can be very useful for
                                                                   someone starting a new business
                                                                   — into start-up costs and running
                                                                   costs.

                                        Fixed costs do not
                                                                    Start-up costs
                                        change as the firm         Whenever a new business is launched,
                                        produces more or less      its owners will have to pay some one-
                                                                   off costs. These costs will not have
       0                                                           to be paid on a regular basis as they
         0                                    Amount produced
                                                 by the business   are associated solely with starting a
     Figure 3.3 Fixed and variable costs                           business. Some examples of start-up
                                                                   costs are shown below:
                  ✱	 Buildings. These are often called ‘premises’. All businesses require some premises,

                     whether they are an office, a shop or a factory. Premises can be either bought or
                     leased. Buying a building requires a business to invest a large sum of money and
                     possibly to take out a special loan called a mortgage. To lease or rent premises,
                     a business will have to pay an initial sum of money to buy the lease and then
                     monthly rent as well.
                  ✱	 Machinery and equipment. Offices need photocopiers, computers and printers.

                     Shops need electronic tills, computers and closed-circuit television (CCTV) for



                                                                                             Finance         3
     security. Factories need production line equipment and computers to manage pro-
     duction. These are all expenses that the firm pays at the start of its life and are
     essential if it is to start trading.
                                              ✱	 Market research. In Chapter 2, we saw

                                                 that market research is the gathering of
                                                 data on consumers’ buying plans and
                                                 opinions on products. Market research
                                                 gives information that helps businesses
                                                 to improve marketing decisions such as
                                                 the price at which the product should
                                                 sell, where it should be sold and the
                                                 design of the proposed good or service.
                                                 However, this can be a costly activity
                                                 before the business starts trading.
                                             A small hotel. What start-up costs might an entrepreneur
                                             have to pay when taking over the hotel in this picture?
   Running costs
   These costs are expenses that a business has to pay regularly as a normal part of
   trading:
   ✱	 Rent. If a business leases its premises, the owners of the buildings will expect to

      receive a payment for the use of these buildings each month. This is rent.
   ✱	 Raw materials and components. Manufacturing businesses use large amounts of

      raw materials and components and have to pay for these regularly. For example,
      a small garage may buy second-hand cars as well as oil, tyres, spare parts and
      petrol on a regular basis. Service businesses such as a local chemist will have to
      pay for stocks of medicines, cosmetics and soap to make sure it has the products
      that its customers want.
   ✱	 Wages. Most businesses employ people and have to pay wages either weekly or

      monthly. Small businesses might only employ one or two people, but they have
      to be paid every week or month and this will be a regular running cost for the
      business.
   ✱	 Business taxes. HM Revenue and Customs collects tax such as value added tax,

      income tax and corporation tax (a tax on company profits) on behalf of the gov-
      ernment. These taxes are paid by businesses quarterly or annually.

Profits
   Profit is the amount by which a business’s revenue from all its sales exceeds its
   costs. A loss is the amount by which a business’s costs are larger than its revenue
   from all sales. The formula used to calculate profits (or losses) is simple:
                            profits (or losses) = revenue – total costs


AQA GCSE Business Studies                                                                               
Unit 1 Setting up a business

         If a new business’s revenue
         is greater than its total
         costs over some period of
                                               Profit
         time, such as a month or a
         year, then the business will                                                   Loss
         make a profit. But if the                      Revenue
                                                          from
         total costs are greater than          Total     selling           Total     Revenue
         the revenue earned by the             costs    products          costs         from
                                                                                       selling
         business, it is said to make                                                products
         a loss. Figure 3.4 illustrates
         the relationship between
         revenue, total costs, losses Figure 3.4 Revenue, total costs, profits and a loss
         and profits.
           Profit is an important measure of success for many new businesses. Most entre-
         preneurs hope that their business will make a profit, but for many this can take
         some time. One reason that many new businesses do not make profits immediately
         is that it can take time to win enough customers to create enough revenue to cover
         total costs. In the longer term, an entrepreneur would expect his or her business to
         make a profit. Profit is the reward for an entrepreneur for taking the risk of start-
         ing a new business.

          Business insight
          Carl Bradley runs a computer shop called Fusion Systems with his wife in Eastbourne, East
          Sussex. He employs three people and the business has an annual revenue of £540,000. In
          December 2008 Carl said that his business’s sales had fallen and therefore the business was
          receiving less revenue. Carl is hoping to see his costs fall, especially his fixed costs.
            What will have happened to Fusion Systems’ profits in December 2008? What might Carl
          do in response?


       Financial calculations                                              Examiner’s tip
         There are a number of important calculations that an             Always show your
                                                                          calculations in
         entrepreneur might do.
                                                                          examinations if you are
                                                                          asked to calculate costs,
       Calculating a business’s revenue                                   revenue or profits. This
         We saw earlier that the following formula is used to             means that the examiner
         calculate the revenue earned by a business:                      may be able to award
                                                                          you some marks, even if
            revenue = selling price × number of products sold             you make an error.

         Examples:
             a restaurant sells its meals for an average price of £20, and attracts 150 cus-
         ✱	 If

           tomers each week, then its weekly revenue is £20 × 150 = £3,000.


                                                                                                 Finance    3
   ✱	 A housebuilder builds and sells five houses each year. The average selling price
     of the houses is £175,000. The business’s revenue = £175,000 × 5 = £875,000.
   If a business increases its price, then the amount of revenue it earns will rise so
   long as it continues to sell the same quantity (or possibly even if the quantity sold
   falls by a small amount). See Table 3.2 for an example of the relationship between
   price and revenue.
                              Table 3.2 Price and revenue for a potter
                                  who sells 100 pots each month
                                      Price per pot   Revenue
                                           £1        £1,00
                                           £1        £1,00
                                           £0        £,000
                                           £        £,00
                                           £0        £,000

     However, it is very likely that if the price of the pots is increased, some customers
   may decide not to buy them and the number of pots sold will fall. This would mean
   that revenue would not rise by the amount shown in the table.

    Key terms
    Price is the amount a business asks a customer to pay for a single product.
    Revenue is the income that a firm receives from selling its goods or services.
    Sales refers to the number of products sold by a business.
    Costs are the spending that is necessary to set up and run a business.
    Profit is the amount by which a business’s revenue from all its sales exceeds its costs.
    Loss is the amount by which a business’s costs are larger than its revenue from all sales.


Using data
   Suppose that, in the potter’s business above, a price of £20 per pot will lead to the
   business selling 85 pots each month and a price of £30 will cause monthly sales to
   fall to 72 pots.
     Calculate the business’s revenue in each of these cases.

Calculating total costs
   This is a simple case of adding two numbers together. Remember:
                            total costs = fixed costs + variable costs
   Examples:
   ✱		Atoy shop has fixed costs of £4,000 per month and in a typical month has vari-
     able costs of £7,525. The shop’s total costs will be £11,525.

AQA GCSE Business Studies                                                                              
Unit 1 Setting up a business

           ✱	 Apig farmer breeds 40 pigs each month. He has calculated that the variable cost
             of producing each pig is £150 and the fixed monthly costs of his farm are £3,000.
             The farm’s total costs each month are: £3,000 + (£150 × 40) = £9,000.

       Calculating profits
           This is probably the most important of these financial calculations. The formula
           used to calculate profits is simple:
                                                            Sales — the number                     Price — what
                  profits = revenue – total costs             of products sold        ×           customers pay
           It is possible to calculate the profits for
           an entire business using this formula                                          gives
           as is shown by the two examples below
           (see Figure 3.5).                                                   Revenue — the
                                                                              business’s income
           Examples:
           ✱	 A café’s revenue each year is £198,000                                      minus
              and its total costs are £168,000 for the
              year. Using the formula above, this                             Total costs — fixed
              means that the business has made a                               and variable costs
              profit of £30,000 over the year.
           ✱	 A tie manufacturer has a monthly                                            gives

              revenue of £28,000. The company’s
              fixed costs are £12,000 each month                                    Profits
                                                                                  (or losses)
              and its variable costs are £9,000. The
              business’s profits =                         Figure 3.5 Important financial relationships

                                           £28,000 – (£12,000 + £9,000)
                                               = £28,000 – £21,000
       	                                       = £7,000 profit each month
           ✱	 Afruit farm sells 10,000 kg a week of apples at 40 pence per kilogram. The busi-
             ness’s variable costs each week are £1,500 and its weekly fixed costs are £2,000.
             The businesses profits are:
                                       (£0.40 × 10,000) – (£1,500 + £2,000)
                                                = £4,000 – £3,500
       	                                        = £500

                  Examiner’s tip
              Make sure you understand the relationship between sales and variable costs.
              Think about the following. If a business’s sales increase what would you expect to
              happen to its variable costs? How might these changes affect its profits?




                                                                                                  Finance    3
    Business insight
    Holly Tucker and Sophie Cornish are managing the rapid
    growth of Notonthehighstreet.com, the business they set
    up 2 years ago. Last year the business’s revenue was
    approximately £800,000 and the partners expect it to rise
    £3.5 million this year. Holly and Sophie are not satisfied,
    however, and are planning to expand their business.
    Notonthehighstreet sources good-quality clothes and gifts
    from small producers and sells them online. Holly says:
    ‘We provide an opportunity for thousands of independent
    suppliers to sell their products. Sites like ours are acting as
    a kind of shop window for the long tail of the internet.’
    (Source: Times Online, 27 July 2008)
      Would you expect the business’s profits to be higher than last year? Explain your answer.



Summary
   This section has introduced you to several very important financial terms: price,
   sales, revenue, costs and profits and has explained the relationship between them.
   It has also shown you how to calculate key financial figures such as total costs,
   revenue and, importantly, profits.

   Quick questions
   1 Explain the difference between sales and revenue, using examples.              (4 marks)
   2 Give an example of a fixed cost and a variable cost.                           (2 marks)
   3 Give the formula used to calculate a business’s revenue.                       (2 marks)
   4 If a business increases its price and sales are unchanged, explain
     what will happen to its revenue.                                               (3 marks)
   5 Explain what would normally happen to a business’s sales if it
     increased its price.                                                           (4 marks)
   6 Give the formula used to calculate a business’s profits or losses.             (2 marks)
   7 If a business’s total costs are higher than its revenue, will it
     make a profit or a loss?                                                        (1 mark)
   8 A business has a selling price of £.0 and sales of ,000
     products each month. Calculate the business’s monthly revenue.                 (3 marks)
   9 A manufacturer’s products each have a variable cost of £ and
     the business produces 0 each month. The business’s fixed
     costs are £,000 per month. Calculate its total costs for a month.             (4 marks)
  10 A business has variable costs of £00 each week and its fixed
     costs are £0 over the same period. Its sales are 0 units each
     week and the price of its products is £. Calculate the business’s
     weekly profits.                                                                (5 marks)



AQA GCSE Business Studies                                                                               
Unit 1 Setting up a business


                                 Section assessment
                                            Nigel’s Honey
         With an inheritance from his father, Nigel Gilpin set up a business at his home to
         produce and sell honey. Nigel gave up a well-paid job to start his business. At first,
         he did not think that his sales were high enough to make a profit, but since then he
         believes that his business has become profitable. Nigel has gathered together his
         costs and revenues (see Table .) and is about to calculate his business’s profits
         for the past year — or is it a loss? Nigel thinks that if his business has made a loss
         over the year the answer is easy: increase the price of a jar of his honey. If he does
         this, he thinks his business would be certain to make a profit.

                                      Table 3.3 Nigel’s costs and revenues
                                    Variable costs per jar of honey   £1.00
                                   Annual fixed costs                 £1,00
                                    Selling price per jar of honey    £.
                                    Sales over the year               ,00


         Questions
         1 Define the term ‘sales’.                                                   (2 marks)
         2 Explain the difference between a profit and a loss.                        (4 marks)
         3 Using the figures above, calculate Nigel’s profit or loss for the year.    (6 marks)
         4 Do you think that Nigel is right to believe that increasing his price is
           a certain way to make a profit? Give reasons for your answer.              (8 marks)


         Extension exercise
         Would it matter if Nigel’s business did not make a profit during its
         first year of trading? Give reasons for your answer.                         (9 marks)




       Using cash flow
           This section introduces you to cash flow and to cash flow forecasts, which are a very
         important tool used to plan and manage the finances of new businesses.
           By the end of this section you should know:
           ✓	what is meant by the term ‘cash flow’
           ✓	how to interpret simple cash flow forecasts and statements
           ✓	why cash flow statements are important to new businesses
           ✓	the ways in which small businesses can solve cash flow problems


                                                                                         Finance    3
What is cash flow?                                                Key term
   There are a number of reasons why a new business
                                                                  Cash flow is the money
   would receive cash inflows and many likely causes of           that flows into and out of
   outflows of cash from the business.                            a business on a day-to-day
                                                                  basis.
Cash inflows
   Cash inflows mean that money becomes available to the business. There are several
   reasons why a business might receive cash inflows:
   ✱	 Income from sales. The money businesses earn from selling goods and services

      creates an inflow of cash to the business. This is often called sales revenue or
      turnover.
   ✱	 Loans from banks. It is common for a new business to borrow money in order to

      buy new items such as vehicles, machinery or property. When the loan is given
      to the business, this becomes a cash inflow for the business.
   ✱	 Money invested by the business’s owners. When a business is first started, its

      owners (sole traders or shareholders, for example) may invest money into the busi-
      ness, resulting in a cash inflow.

Cash outflows
   When a business makes a payment it causes an outflow of cash. A number of
   actions can lead to a cash outflow:
   ✱	 Establishing the business. Starting a new business requires a number of one-off

      payments, such as advertising the new business and buying equipment and vehi-
      cles, that lead to cash outflows.
                                                          ✱	 Buying raw materials.

                                                          Most businesses need to buy
                                                          some raw materials to allow
                                                          them to trade normally. For
                                                          example, a newly opened
                                                          restaurant will need to buy
                                                          ingredients to make into
                                                          meals as well as buying a
                                                          stock of alcoholic and non-
                                                          alcoholic drinks to sell to its
                                                          customers.
                                                    Buying a van can cause a major cash
                                                 outflow for a business. Why might a new
                                                    business choose to lease (rent) a van?

   ✱	 Wages.All businesses, particularly those selling services, suffer an outflow of
     cash due to the payment of wages to employees.

AQA GCSE Business Studies                                                                      
Unit 1 Setting up a business

         ✱	 Rent. Many businesses rent the buildings in which they are housed. These may
            be shops, offices or factories. This means they have a regular outflow of cash to
            pay their rent (or mortgage).
         ✱	 Interest on loans. We saw earlier that a bank loan leads to an inflow of cash.

            Paying interest on the loan, however, leads to regular (possibly monthly) cash
            outflows.
         ✱	 Taxes. Businesses have to pay sales taxes and taxes on profits. Both of these cause

            cash outflows.
                              Examiner’s tip             Time is a very important issue in
                              Do not write about         relation to cash flow. Entrepreneurs
                              profits if the question    need to be aware that if outflows
                              is on cash flow. These
                                                         of cash occur before inflows take
                              are two very different
                              concepts.
                                                         place, the business is likely to be
                                                         short of cash. Thus, when managing
                                           cash flow, entrepreneurs should attempt to ensure
                                           that cash inflows take place in time so that the
                                           funds are available to finance cash outflows.


                                       Why might house builders experience a large time
                                          gap between cash outflows and cash inflows?




       Interpreting cash flow
                                                                  Key terms
       forecasts and statements                                   A cash flow forecast is a
         It is possible to construct a table of the inflows and plan of the expected inflows
         outflows of cash that are expected by a business’s     and outflows to and from a
         managers. When such tables are drawn up as part        business over a period of time.
                                                                A cash flow statement is a
         of the process of planning a business they are
                                                                historical record of the cash
         called cash flow forecasts. However, when com-         inflows and outflows that
         pleted as a record of trading they are called cash     have taken place over a period
         flow statements. A business may use a cash flow        of time.
         statement to look at what happened to cash flows
         over a previous trading period and use this to help it plan its future management
         of cash. For example, it might see that last year it was very short of cash during
         the Christmas period. Knowing this, the entrepreneur can take actions to avoid the
         same problem occurring again this Christmas.
            The cash flow forecast in Table 3.4 was drawn up by Peter and Sue, who are plan-
         ning the opening of a restaurant to be called ‘Sue’s’.

0
                                                                                          Finance    3
                            Table 3.4 Peter and Sue’s cash flow forecast
                                                    December     January       February
            Cash inflows
            Peter and Sue’s savings                    ,000
            Bank loan                                  ,00
            Sales revenue from ‘Sue’s’                 ,00       ,000         ,00
            Total cash inflow (A)                    16,300         6,000        8,800
            Cash outflows
            Purchase of stocks of food and drink       ,000       ,0         ,00
            Wages                                     ,000        ,00         ,00
            Interest on bank loan                       0          0          0
            Rent (for  months)                        ,0               –         –
            Electricity and gas                         0          0          10
            Total cash outflow (B)                    16,750        8,220        8,060
            Net cash flow (C = A - B)                   (450)      (2,220)        740
            Opening balance (D)                        1,000         550        (1,670)
            Closing balance (E = D + C)                  550       (1,670)        (930)
   Cash flow forecasts and statements are normally organised into three sections:
   ✱	 Cash inflows are normally at the top. When added together, the cash inflows

      equal the ‘total cash inflow’ (A).
   ✱	 The second section is cash outflows. These are added together to give the ‘total

      cash outflow’ (B).
   ✱	 The third section includes the net cash flow, the opening balance and the closing

      balance.
      ◆	 The row called ‘net cash flow’ (C) shows the net flow of cash into and out of the

         business. It is calculated by taking the ‘total cash outflow’ (B) from the ‘total
         cash inflow’ (A).
      ◆	 The amount of cash held by the business at the start of the month is shown by

         the ‘opening balance’ figure (D). This is the figure the business had as cash on
         the last trading day on the previous month. In the case of ‘Sue’s’ this date was
         30 November. So the closing balance for one month becomes the opening bal-
         ance for the next month.
      ◆	 Finally, the amount of cash the business has at the end of the month is shown

         by the ‘closing balance’ figure (E). The closing balance is calculated by adding
         together the opening balance (D) and the net cash flow (C).
   All negative figures are shown in brackets. For example, in Peter and Sue’s forecast
   the net cash flow for January and the closing balance for February are negative.

Interpreting Peter and Sue’s cash flow forecast
   What can Peter and Sue learn from their cash flow forecast? The major piece of
   information it contains is that their business will be short of cash in January and

AQA GCSE Business Studies                                                                       1
Unit 1 Setting up a business

         February. The forecast shows that by the end of January they will have spent £1,670
         more than the business has available. This poses a real problem for the business, as
         it will not have enough cash to pay its suppliers of food and drinks or possibly the
         wages of staff. In February the cash position is little better — they will again not
         have enough cash, although this time the negative figure is smaller at £930.
            The cash flow forecast also gives Peter and Sue detailed information about what
         is causing the cash inflows and outflows. This information will help them to make
         decisions on how to improve the cash position of their business. We will consider
         this later in this section.
            Table 3.5 shows the cash flow statement for Peter and Sue’s restaurant after its
         first month of trading in December.

                        Table 3.5 Peter and Sue’s cash flow statement for December

                                                                   December
                            Cash inflows
                            Peter and Sue’s savings                  ,000
                            Bank loan                                ,00
                            Sales revenue from ‘Sue’s’               ,00
                            Total cash inflow                       16,700

                            Cash outflows
                            Purchase of stocks of food and drink     ,00
                            Wages                                    ,100
                            Interest on bank loan                      0
                            Rent (for  months)                      ,0
                            Electricity and gas                        0
                            Total cash outflow                      16,720
                             Net cash flow                             (20)

                            Opening balance                          1,000
                             Closing balance                           980



       Interpreting Peter and Sue’s cash flow statement
         This statement is very helpful for Peter and Sue. They can compare their cash flow
         forecast with the actual situation shown in the statement. If you look back at their
         forecast on page 71, you will see that they received more cash inflows in December
         than they expected — £16,700 rather than £16,300. Their cash outflows were just
         a little higher (mainly due to spending more on wages than forecast). As a result,
         their cash outflows for the month were only £20 higher than their inflows. Do you
         think Peter and Sue be pleased with the information given in this cash flow state-
         ment? Why?


                                                                                        Finance          3
Importance of cash flow forecasts and cash
flow statements
   It is common for a new business to experience cash flow problems. These can be
   managed if the entrepreneurs are aware of the possibility and are prepared to take
   the necessary actions to overcome them.
      Constructing cash flow forecasts helps entrepreneurs in two main ways:
   ✱	 They can identify times when the business might be short of cash.

   ✱	 They can take action to avoid cash shortages becoming a major problem.


   Problems arising from cash shortages will vary
   from business to business. For example, Peter Examiner’s tip
   and Sue may not have enough cash to pay Do not always think that cash flow
                                                       problems will lead to a business
   their bills and, because they are a new busi- becoming insolvent and having to stop
   ness, suppliers may be unwilling to continue to trading. In many cases, entrepreneurs
   deliver goods (such as food and drinks) without and managers can take actions to
   receiving payment. Their cash flow forecast overcome the problems.
   will help Peter and Sue to plan ahead and avoid
   difficult trading periods. The couple can see that they may be short of cash during
   January and February and should be able to take steps to remedy the situation.
     In addition, managers or the owners of businesses can use flow forecasts and
   statements when applying to banks for overdrafts and other loans. Banks are more
   likely to lend money to businesses that have forecast their cash flow or have state-
   ments to show their cash flow position. Such small businesses are less likely to have
   unexpected cash flow problems. This makes lending to these businesses less risky
   for banks.
     Cash flow statements also help entrepreneurs and managers to understand where
   and when their cash was spent. This may assist them in making decisions on how
   to reduce cash outflows if this is necessary. In the same way, the statements show
   the timing and sources of cash inflows. Having this information helps managers to
   decide how to improve cash inflows if necessary.

Consequences of cash flow problems
   Businesses cannot continue to trade without having            Key terms
   enough cash to pay bills as they arrive. Managing cash
                                                                 Insolvency occurs when a
   carefully is therefore an important task for managers. If
                                                                 business is not able to meet its
   a business does not have enough cash to pay its bills it is   financial commitments when
   said to be insolvent and has to stop trading by law.          they are due.
     When a business becomes insolvent, a person called          A receiver is a person who
   a ‘receiver’ is appointed to administer the business. The     takes responsibility for an
   receiver will try to sell the business as a whole and as a    insolvent business and makes
                                                                 arrangements to pay its debts.
  ‘going concern’. This may not be possible because potential

AQA GCSE Business Studies                                                                           
Unit 1 Setting up a business

         buyers may not think that it will ever be successful. In this case, the receiver will
         probably decide to close the business down and sell its assets (such as vehicles and
         stocks of raw materials) to raise as much money as possible. This money will be paid
         to the businesses and individuals to which the business owes money. A business
         administered by a receiver is said to be ‘in receivership’.

          Business insight
          Table 3.6 shows that in 2007 10% of small businesses thought that cash flow was the
          biggest obstacle to success. This includes small businesses that have just started up as well
          as those that have been trading for many years.

                                       Table 3.6 Obstacles to business success
                                 Obstacle                                 Percentage
                                 Competition in the market                    1
                                 Regulations                                  1
                                 Taxation                                     1
                                 The state of the economy
                                                                              10
                                 (e.g. whether in recession)
                                 Cash flow                                    10
                                 Recruiting staff                                
                                 Shortage of skills generally                    
                                 Availability/cost of suitable premises          
                                 Obtaining finance                               
          (Source: Annual Small Business Survey, Department of Business and Regulatory Reform)
            Which of the first five obstacles does an entrepreneur have some control over?


       Solutions to cash flow problems
         When faced by cash flow problems, entrepreneurs such as Peter and Sue may take
         one of a number of actions. The ‘best’ action to take will depend on the business’s
         circumstances. So, for example, if its prices are lower than those of its competitors,
         a price increase may be a good choice:
         ✱	 Delay payments. It may be possible for a business to agree with its suppliers, or

            others to whom it owes money, to delay its payments (outflows). If this gives
            sufficient time for the business to receive inflows of cash, the problem may be
            solved.
         ✱	 Speed up cash inflows. This could be achieved by persuading new customers to

            pay on delivery. Alternatively, customers who owe the business money could be
            chased up and persuaded to pay promptly.
         ✱	 Find new sources of cash inflows. It may be possible for a business to generate

            extra cash inflows. For example, a couple running a bed and breakfast business
            in a tourist area could increase cash inflows by deciding to offer evening meals.


                                                                                                 Finance    3
       Business insight
       In 2008 many builders were experiencing difficulty in selling houses because people
       interested in buying new homes were finding it hard to arrange loans (known as mortgages)
       with banks or building societies. As a result, house sales fell significantly, meaning that
       house builders suffered a major fall in their cash inflows. As a solution, many small house
       builders rented unsold finished properties to people who couldn’t borrow money and in this
       way received inflows of cash each month.

      ✱	 Reduce   cash outflows. This could mean employing fewer staff, or holding smaller
         stocks of raw materials. Alternatively, the business could seek to use cheaper
         sources of fuel or raw materials.
      ✱	 Arrange an overdraft with the bank. An overdraft is a short-term, flexible loan

         that can provide the business with the cash that it needs. Overdrafts can, however,
         be a relatively expensive form of borrowing.
      ✱	 The owners could invest more money into the business. This is an interest-free

         source of finance for the business but is only a possibility if the owners have suf-
         ficient funds.

Examiner’s tip                  Most of the proposed solutions above have disadvantages.
Solutions to cash flow          For example, advertising the product more widely will
problems often bring their      involve additional costs, causing outflows of cash. When
own problems. In answering      suggesting solutions to cash flow problems you should bear
higher mark questions on        in mind the possible disadvantages of your proposals.
cash flow you may need to
                                                           Cash flow forecasts are only
mention these.
                                                         predictions and may not prove to
                                                         be accurate. Inaccurate forecasts
                                                         are common for new businesses,
                                                         as they do not have any cash flow
                                                         statements to compare the fore-
                                                         casts against. The business’s cash
                                                         position could be better (or worse)
                                                         than the forecast suggests.

                                                      Why might this business run short of cash?

   Summary
      Cash flow is the money flowing into, and out of, a business over a period of time.
      Businesses forecast their cash flows and record the actual flows on cash flow state-
      ments. Businesses that suffer cash flow problems may face difficulties in paying
      bills and, in extreme circumstances, may be forced to close down. Entrepreneurs
      can take a number of actions to improve their cash flow position, including
      rescheduling payments and arranging overdrafts.

   AQA GCSE Business Studies                                                                           
Unit 1 Setting up a business

         Quick questions
         1 What is the difference between a cash inflow and a cash outflow?           (3 marks)
         2 Describe two sources of cash inflow for a small hotel.                     (4 marks)
         3 Describe two sources of cash outflow for a bakery.                         (2 marks)
         4 What is the difference between a cash flow statement and a cash
           flow forecast?                                                             (4 marks)
         5 State two reasons why cash flow statements are important to
           small businesses.                                                          (2 marks)
         6 State two reasons why cash flow forecasts are important to
           small businesses.                                                          (2 marks)
         7 If a business suffers very severe cash flow problems, it may
           become insolvent. What is insolvency?                                      (2 marks)
         8 What does a receiver do?                                                   (3 marks)
         9 State two ways in which a business might speed up its cash inflows.        (2 marks)
        10 Explain two actions a business might take to improve its
           cash flow position.                                                        (6 marks)




                                  Section assessment
                                        Kimmi’s Garage
         Kimmi had achieved her dream. Her aunt had left her money in her will and at last
         she was able to open her own garage repairing and servicing cars. She was con-
         fident she would succeed, but after  months trading she had experienced some
         problems, especially with cash flow. Kimmi was a qualified mechanic and had
         planned her business carefully. However, she was disappointed with the figures
         in her cash flow statement (see Table .) as they were very different from the
         figures set out in her forecast. At one point, she had worried about her business
         becoming insolvent.

                                   Table 3.7 Kimmi’s cash flow statement
                                                 January     February      March     April
            Cash inflows
            Kimmi’s inheritance                   1,00
            Bank loan                               ,000
            Sales revenue                             00       ,0        ,0      ,0
            Total cash inflow                     131,000        3,750       3,950      4,250





                                                                                                Finance    3
                                            January      February    March       April
      Cash outflows
       Purchase of buildings                 10,000
       Wages                                   1,00       1,00       1,00        ,000
       Interest on bank loan                     0         0         0             0
       Purchase of tools and materials        10,00       1,00         00             00
      Telephone and fuel                         0         10         10             10
       Marketing                               1,000         00         00             00
       Total cash outflow                    133,600       4,200        3,300        3,410
       Net cash flow                          (2,600)        (450)       650             840

       Opening balance                         1,500       (1,100)     (1,550)       (900)
       Closing balance                         (1,100)     (1,550)      (900)            (60)


   Questions
   1 Define the terms ‘cash flow’ and ‘insolvency’.                               (4 marks)
   2 Explain why Kimmi might have been disappointed with the figures
     in her cash flow statement.                                                  (6 marks)
   3 Discuss the factors that might have caused the cash flow problems
     for Kimmi’s business.                                                       (10 marks)


   Extension exercise
   Kimmi’s business was short of cash during its first  months of trading, as shown above.
   Discuss the actions she might take to improve her business’s cash flow in the future.




Chapter review
1    Read Item A and answer the questions that follow.

                                          Item A
   Usha Hills started her new business last month. Home Angels offers a cleaning serv-
   ice for busy people in the town where Usha lives. She had to raise £0,000 to set up
   her business — to buy two vans, cleaning equipment and materials and for market-
   ing. She turned down an offer of an interest-free loan from her mother and borrowed
   £1,000 from a bank. Usha has one employee and her business has already achieved
   sales of cleaning  homes a month and she expects a further rise in sales. She is
   confident that her business has made a profit in its first month and has gathered
   together details of the business’s costs and revenues (see Table .). Usha has man-
   aged her business’s cash flow carefully and has not needed to use her overdraft.


AQA GCSE Business Studies                                                                             
Unit 1 Setting up a business

                                       Table 3.8 Usha’s costs and revenues
                                  Monthly costs
                                  Fixed costs                        £0
                                  Variable costs per home cleaned    £0
                                  Revenue
                                  Selling price                      £
                                  Sales                               homes


         (a) What is meant by the term ‘overdraft’?                                          (2 marks)
         (b) What is meant by the term ‘cash flow’?                                          (2 marks)
         (c) Explain how a ‘…rise in sales…’ might affect the profits made
             by Usha’s business.                                                             (4 marks)
         (d) Calculate the following figures for Usha’s business for the first
             month of trading:
              (i) total costs
             (ii) revenue                                                                    (6 marks)
         (e) Explain how an organisation such as Business Link might have
             helped Usha to set up and manage her new business.                              (7 marks)
         (f) Do you think that a bank loan was the best source of finance for
             Usha’s business? Give reasons for your answer.                                  (9 marks)



       Answers
         (a) An overdraft is a special form of loan. It can be got from a bank and can be paid
             back whenever the business wants. The good thing about this type of loan is that
             the business does not have to use it unless it needs to.
               This is not a particularly good answer for two reasons. It is too long for a question
               worth only 2 marks and it does not state clearly that the loan is flexible, although
               this is hinted at in the final sentence. Do not rush into answering the first question
               on an examination paper. Take a minute or so to think clearly and to plan your
               answer in your mind.

         (b) Cash flow is the money that goes into and out of a business each month.
               This is an excellent answer and much better than the previous one. The candidate
               has clear knowledge of this term and has given a very brief and accurate answer.

         (c) Sales are the number of products sold by a business. Usha’s sales are the number of
             homes her business cleans. She expects this to rise above 75 in the second month
             and this should give her more revenue. Usha’s variable costs will increase if her sales
             do. If her business’s costs do not increase too much the rise in sales will give her more
             profits in the second month.


                                                                                                  Finance    3
         This answer starts well by defining the important term in the question (sales) and
         then links it to the case study business very effectively. In particular, it is impressive
         that the candidate explains that a rise in sales will increase costs and that this rise
         mustn’t be too large or profits will not increase. The answer is quite brief, but
         includes everything that is needed to gain a top mark.


   (d) (i) £2,250                 (ii) £2,300
         The candidate makes a serious error in not showing workings here. Part (i) is
         correct and will receive 2 marks. However, the second answer is wrong. Probably
         the candidate has made a mistake when calculating the answer, but the examiner
         has no choice but to award 0 marks. (With workings it is quite possible that 1 mark
         would have been awarded.) It is a good idea to start your answer to calculations by
         writing down the formula. You will receive at least 1 mark for this and it will help to
         guide you through the calculation.


   (e) Business Link is a government organisation set up to help small businesses and works
       in all areas of Britain.
          Business Link could help Usha by telling her about cash flow and how to manage
       it to avoid problems. The website could give her help on doing a cash flow forecast
       and then using it to get a loan which she actually borrowed from a bank. This might
       help her to get a cheaper loan.
          The other thing it would do is to help her by listing other sources of information.
       Usha might not have run a business before and she might have wanted to talk to
       someone who is an expert about it. Business Link could put her in contact with
       someone who lives near to her.
         This is an excellent answer. The opening description of Business Link shows good
         knowledge (though other organisations, such as banks, could have been used). The
         candidate then explains how Business Link could have helped Usha. It is good to
         see that the answer is linked to Usha’s business and not just written in general terms
         about any business. This skill of applying your knowledge to the business set out in
         the question is very important in answering questions in examinations.


   (f) There are many sources of finance that Usha could have used. She could have
       borrowed money from her mother without having to pay any interest, meaning that
       she would just have had to repay the actual money without paying any extra interest
       on top. This would have helped Usha to make a profit or a bigger profit than she
       actually made, which was only £50.
         However, I think that Usha was probably right to borrow the money from a bank.
       Her mother might have needed the money back and this would have left Usha with
       a big problem. Also she has made a small profit and this is good in her first month
       so paying interest on the loan from the bank has not really been a problem and her
       business should make bigger profits in the future.

AQA GCSE Business Studies                                                                               
Unit 1 Setting up a business

               The first sentence is fairly vague. It would have been better to start by
               defining ‘source of finance’. However, this is a good answer. It presents a
               clear argument on why Usha might have taken up her mother’s offer of a
               interest-free loan and has then balanced this by making and supporting a
               decision that Usha did the right thing by taking out a bank loan. The question
               specifically asked for this final judgement so it was very important to include it.
                 Overall, despite a couple of weaknesses, the candidate has answered this set
               of questions well and has shown good knowledge and the ability to develop
               arguments and relate them to the business in the question. This answer would have
               received a grade A.



        2 Read Item B and answer the questions that follow.
                                               Item B
         Pete Lucas set up his sandwich shop a year ago. The first year of trading has
         been difficult, although Pete believes that he has earned enough revenue to make
         a profit over the entire year. He plans to work this out, but is not sure how to do
         so. Pete has enjoyed running his business but has had some cash flow problems.
         Without an overdraft, he has often been short of money to pay wages and his sup-
         pliers. Some of his business customers have been slow to pay him. Pete is worried
         because his cash flow problems seem to be getting worse, not better. Last month
         he had to borrow money from his father to pay his assistant’s wages. His father has
         told him that he should talk to a business adviser to get some help.

         (a) What is meant by the term ‘revenue’?                                       (2 marks)
         (b) What is meant by the term ‘cash flow statement’?                           (3 marks)
         (c) Explain how Pete would calculate his business’s profit or loss
             for the first year of trading.                                             (4 marks)
         (d) Explain two possible consequences of Pete’s business
             continuing to have cash flow problems.                                     (6 marks)
         (e) Explain why Pete might want to talk to a business adviser.                 (6 marks)
         (f) Discuss how Pete might respond to his cash flow problems.
             Give reasons for your answer.                                              (9 marks)




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